Fed warns US financial system remains vulnerable to threats

WASHINGTON — The Federal Reserve is warning that the U.S. financial system remains vulnerable to threats stemming from the global pandemic, including the possibility of a sharp rise in global interest rates that could strain developing countries.

A worsening of the pandemic could stress the financial systems in emerging markets and some European countries, the Fed said in a report Thursday.

The risk of instability in those markets could interact with existing vulnerabilities at U.S financial institutions and “pose additional risks to the U.S. financial system,” the Fed said.

That finding was included in the Fed’s twice-a-year “Financial Stability Report.” The central bank has been publishing the report since 2018 in an effort to highlight and address potential threats to the U.S. financial system with the aim of preventing a repeat of the 2008 financial crisis.

Recent developments explored in the report include the March collapse of Archegos Capital Management, which generated more than $10 billion in losses at top global banks.

Fed board member Lael Brainard, who chairs the central bank’s financial stability committee, said in a statement that the failure of Archegos “highlights the potential for nonbank financial institutions such as hedge funds and other leveraged investors to generate large losses in the financial system.”

She said the incident demonstrated the “limited visibility” regulators have into hedge-fund operations.

“The potential for material distress at hedge funds to affect broader financial conditions underscores the importance of more granular, higher-frequency disclosures,” Brainard said.